Yesterday was election day across the country.  While I trust that all voters exercised their best judgment in casting their ballots, this article is a reminder for lenders to exercise due care in voting as a creditor on a Chapter 11 bankruptcy plan.  Although the Presidency is not up for grabs in a Chapter 11 case, a lender could cause serious damage to its SBA guaranty if the lender votes carelessly in favor of a Chapter 11 plan. 

When a borrower enters a Chapter 11 bankruptcy, the borrower has the exclusive right (for a set period of time) to devise and seek court approval for a plan of reorganization.  Typically, the borrower will draft its bankruptcy plan in collaboration with its secured lenders.  If the borrower and the secured lenders reach agreement on the plan, the secured lenders obviously are expected to vote in favor of the plan as part of the court approval process.

 

But if an SBA lender fails to consult the SBA regulations prior to casting its vote, the lender could be subjected to a significant repair or outright denial of its SBA guaranty purchase request.  The SBA Servicing and Liquidation Actions Matrix clearly lists the servicing and liquidation actions that require either prior notice or prior approval of the SBA.  If the Matrix requires prior notice or SBA approval, that requirement remains in place even if the contemplated action will take place under a bankruptcy plan.  The requirement also remains in place even if the proposed plan represents the best possible recovery for the lender.

 

For example, the Matrix requires the SBA's prior approval for a lender to compromise the principal balance of an SBA loan.  If the borrower's bankruptcy plan contemplates reducing the principal balance of the loan, the lender must get the SBA's approval before voting in favor of the plan.  If the lender fails to get SBA approval and votes in favor of the plan, the SBA subsequently could repair the SBA guaranty for the amount of the principal reduction or potentially deny the guaranty altogether.  Other plan issues an SBA lender should watch out for include borrower bankruptcy discharges being extended to non-debtor guarantors under the plan or where the reorganization involves transferring assets to a new entity owned or controlled by insiders, affiliates or relatives of the borrower.

 

SBA regulations require lenders to analyze bankruptcy plans and vote accordingly.  If SBA approval or notice is required but not obtained, the lender should object to the plan or vote against it.  Voting abstention is not an option because analysis and action is required under the regulations.  The regulations are silent regarding instances where the court approves a plan over the lender's objection or lender's negative vote.  A repair or denial logically should not be appropriate if the lender opposed an objectionable plan.  In those instances, the SBA would determine whether repair or denial was necessary based on the facts and circumstances of the particular case.

 

For SBA lenders, the bottom line is that the requirements of the SBA Matrix apply even when the borrower is in bankruptcy.  Lenders should negotiate the best deal possible with a borrower in bankruptcy, but lenders should make sure they obtain all required SBA approvals and/or provide all required notices.  SBA lenders can use leverage in bankruptcy to negotiate very good outcomes.  But an SBA lender's best deal remains the SBA guaranty.  SBA lenders should never lose sight of that, even when operating in the fog of a borrower bankruptcy.